Why has the US grown so much faster than the eurozone?

Growth in the US economy has outpaced that of the eurozone in recent years. In this month’s commentary our Chief Economist, Colin Warren, looks at some of the reasons why.

We noted in last month’s commentary that the consensus expects Gross Domestic Product (GDP) growth in the US to outperform that in the eurozone in 2025. If this is the case, it will continue a trend that has been seen in recent years. Since the fourth quarter of 2019 (i.e. before the pandemic) the US has seen a rise in real GDP of 11.4%, compared with an increase of just 4.6% in the eurozone[1]. This begs the question why the US economy has performed so much better than that of Europe. In this month’s article, we look at some of the reasons why.

Productivity

The stronger growth performance of the US compared to the eurozone has been the result of the interplay of various factors, both structural and cyclical. Part of the explanation lies in the superior productivity growth experienced in the US. Since 2019, US output per hour worked has increased by nearly 7%, whereas the euro area has seen a rise of about 1%[2].

Improved productivity is important as it allows economies to produce more goods and services with the same amount of labour, thereby facilitating faster economic growth. Higher productivity allows businesses to generate greater profits and enables them to pay higher wages to employees, leading to higher levels of economic wellbeing. It also means that companies can become more competitive in international markets.

Investment and innovation

So why is productivity in the US higher than in Europe? One reason is that the US has consistently allocated a larger portion of its GDP to investment in advanced technologies (computers, artificial intelligence, software, etc.), and research and development (R&D). The US allocates around 5% of its GDP to technology investments and 3.5% to R&D, compared to 2.8% and 2.3% respectively in the eurozone[3].

The US also benefits from its world-class universities—seven of the top 10 globally are American[4]—and a light-touch regulatory environment that encourages experimentation and innovation. These factors have resulted in the US holding far more world-class patents in advanced digital technologies (currently around 49,000) than the EU (around 10,000)[5].

In turn, US firms have been more proactive in integrating innovative technologies and digital tools, such as artificial intelligence and cloud computing, into their operations. This digital transformation has streamlined processes, boosted efficiency, and ultimately facilitated stronger GDP growth. In contrast, European companies have been slower in adopting these technologies, further widening the productivity gap.

Deep financial markets

A key factor that has enabled the US to invest more in advanced technology and R&D has been its deep financial markets. Ready access to risk capital in the US has made it easier for innovative, productive new firms to expand, and thereby contribute to economic growth. The IMF noted in a recent study that ‘tech’ start-ups typically seek funding from venture capital (VC) firms, but VC finance is underdeveloped in Europe and tends to focus on national markets to avoid the complexities of cross-border regulations[6].

This leaves European ‘tech’ start-ups turning to banks for finance. However, securing bank funding can be difficult because technology companies often lack the traditional physical collateral that banks require for loans, as their primary assets tend to be intangible (e.g. intellectual property and technological know-how). As a result, many European start-ups end up relocating to the US[7]. The EU is developing plans for a Capital Markets Union to improve capital flows, but progress has been slow and the region is a long way from challenging the deep markets that are a hallmark of the US.

Flexible, integrated labour market

A flexible and integrated labour market also helps explain the outperformance of the US economy. In the US, a lightly regulated labour market and a common language allows workers to readily move between companies and regions. This mobility helps the economy reallocate labour from declining industries to high-productivity sectors, and fosters business dynamism by facilitating the growth of new businesses. In contrast, more restrictive labour laws, higher employment protection and language barriers can hamper this process in the EU.

Although European workers tend to benefit from greater job security, this might come at the cost of wage growth over the longer term if labour is allocated inefficiently. American workers are more likely to switch jobs than their European counterparts[8], and evidence suggests that job switchers secure higher wages than workers who stay with the same company[9]. This suggests that job switchers tend to move to companies that utilise their skills more effectively, which in turn will boost productivity in the economy more broadly.

A big single market

The US also benefits from a fully integrated single market with over 330 million consumers operating under a unified regulatory framework. Such a large domestic market has several advantages. It enables businesses to scale up operations easily and quickly, facilitating a reduction in unit costs through economies of scale. It also means that companies can spread fixed costs, such as R&D and marketing, over a larger customer base.

In contrast, the European market is fragmented by language barriers and cultural factors, which limit the ability of firms to scale up at pace. Despite the existence of the EU single market, national regulatory differences between EU countries persist in several key areas, most notably in services. These differences create barriers to trade and investment which limit the ability of European firms to grow as rapidly as their American counterparts.

It is no coincidence that some of the biggest companies globally originate from the US. Platforms like Amazon, Google, and Microsoft grew rapidly in part due to access to a large, integrated market, which has enhanced innovation and productivity.

Interest rate impact

As well as long-term structural factors, there have also been cyclical factors that have contributed to the US growth outperformance versus Europe. Both the US Federal Reserve (the Fed) and the European Central Bank (ECB) raised interest rates sharply to quell the post-pandemic rise in inflation. However, the ECB’s hikes had a more pronounced cooling effect on the eurozone’s economy.

This is because the eurozone relies heavily on bank lending to finance businesses and households. While banks are the primary source of credit for companies in the eurozone,  the US financial system is more market based, with companies relying more on capital markets (e.g. by issuing corporate bonds). As a result, when the ECB hiked rates, it directly increased the cost of bank credit, which had a larger impact on European businesses.  As many US companies issued long-maturity bonds during the pandemic when yields were low, they were less affected when the Fed raised interest rates.  

Similarly, European households (who tend to have more variable-rate and short-term, fixed rate mortgages) were more affected by rising debt costs than American homeowners, who predominantly hold long-term, fixed-rate mortgages (with typical maturities of 15 or 30 years).

Energy costs

European consumers and businesses have also been hit hard by the spike in energy prices following Russia’s invasion of Ukraine in 2022. In contrast, the US - as the world’s top producer of oil and natural gas, and a net energy exporter - has been shielded from the fallout.

Energy prices have fallen back from the highs seen in 2022. However, a recent report on European competitiveness by former ECB chief Mario Draghi noted that prices for electricity in the EU are still 2-3 times higher than in the US, and natural gas prices are still 4-5 times higher[10].  As a result, household budgets have been squeezed and the competitiveness of European companies has taken a hit, causing many manufacturing businesses to cut production, relocate, or close altogether.

Consumer attitudes

Against the backdrop of high energy prices and elevated debt servicing costs, it is perhaps not surprising that consumers in the eurozone have been more hesitant to spend than their American peers. Personal savings rates (i.e. the proportion of household income that is saved and not spent) in both the US and the eurozone spiked during the pandemic, as lockdowns curbed spending. However, US consumers have been keener to splash the cash during the years after. Since the pandemic, the personal savings rate in the eurozone has remained above the pre-pandemic average of 12.3%, and in the second quarter of 2024 stood at 15.7%. In contrast, during the years after the pandemic, the US savings ratio has been below the pre-pandemic average of 6.1%, and was just 4.9% in Q2[11].

A more powerful wealth effect in the US might partly explain American consumers’ greater inclination to spend. American households tend to have more of their financial wealth tied up in the stock market, and with US equities rising sharply through last year, they might feel that their investment portfolios are doing their saving for them.

Pandemic response/fiscal policy

The different approach of the authorities in the US and the eurozone to pandemic support has also influenced productivity and growth trends in recent years. The fiscal stimulus at the peak of the pandemic in 2020 was larger in the US (over 5% of GDP) than in the eurozone (4% of GDP)[12]. However, whereas support to workers in the eurozone focused on furlough schemes which allowed employees to remain attached to their employers, the US focused on direct payments (e.g. stimulus cheques) and enhanced unemployment insurance for workers who lost their jobs.

The European approach, characterized by workers remaining in their existing roles, may have hindered the movement of labour to more productive sectors or firms. By contrast, the US approach facilitated greater labour mobility and the reallocation of workers toward sectors that were expanding during the recovery, such as technology and logistics. Labour shortages and the rising cost of rehiring also prompted American firms to adopt technology and automation more rapidly. These factors have no doubt contributed to the US outperforming the eurozone in terms of productivity and growth in recent years.

In general, US fiscal policy has been more supportive of growth in recent years. While budget deficits in both regions have fallen back from the highs in 2020-21 as pandemic programmes have been wound up, fiscal policy in the US has remained historically stimulative. The general government cyclically-adjusted primary balance (i.e. the budget deficit adjusted for the economic cycle and excluding debt interest payments) was 3.7% of GDP in 2024, compared to just 1.2% in the eurozone according to IMF data[13]. Furthermore, the US has been able to run large budget deficits without incurring the wrath of investors due to the large and liquid market in US government bonds, and the reserve status of the US dollar, which results in relatively low borrowing costs.

American exceptionalism?

The eurozone’s growth has lagged behind the US in recent years due to the interplay of a range of factors including weaker productivity, slower technological adoption, less integrated labour and product markets, and higher energy costs. Although the eurozone could receive a cyclical boost as interest rates fall, the region’s structural disadvantages and greater emphasis on fiscal discipline are likely to continue to weigh on its relative performance. Fostering technological innovation, improving access to finance and reducing energy costs by expanding renewables capacity would help close the growth gap, but progress has been slow.

To be sure, some of the policy proposals of the Trump administration (tariffs, immigration curbs etc.) carry downside risks for both the domestic and global economy. And debt sustainability remains a concern. Any pull-back in equity markets could weigh more heavily on US consumers and trigger a bounce-back in the savings rate, which would dampen spending. However, barring major policy missteps, the US seems unlikely to lose its edge over Europe anytime soon.

Tuesday 18 February 2025